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Long term tax on equity made taxable (Relevant for GS Prelims, GS Mains paper III)

The Finance Act, 2018 has withdrawn the exemption under clause (38) of Section 10 of the Income-tax Act, 1961 (the Act) and has introduced a new section 112A in the Act, to provide that long term capital gains arising from transfer of a long-term capital asset being an equity share in a company or a unit of an equity oriented fund or a unit of a business trust shall be taxed at 10 per cent of such capital gains exceeding one lakh rupees. The said section, inter alia, provides that the provisions of the section shall apply to the capital gains arising from a transfer of long-term capital asset being an equity share in a company, only if securities transaction tax (STT) has been paid on acquisition and transfer of such capital asset.

What is LTCG?
Long-term capital gains (LTCG) refer to the profit made on sale of any asset held for a particular period of time. In case of equity shares, it refers to the profit made on shares held for more than one year. In other words, if the shares are bought and kept for more than a year before selling, then the profit, if any, on the said sale are referred to as long term capital gains (or LTCG). The tax on LTCG is called LTCG tax.

Why is LTCG tax in the news?
In Budget 2018, Finance Minister Arun Jaitley re-introduced LTCG tax on equity shares. Investors have to pay 10% LTCG tax on gains exceeding Rs. 1 lakh on the sale of shares or equity mutual funds held for more than one year. Gains arising on shares held for less than 1 year are called Short-term capital gains (STCG). STCG are taxed at rate of 15%.

In other words, the Centre said that if the gains exceeded Rs. 1 lakh in a year, then 10% LTCG tax had to be paid without the benefit of indexation. Indexation refers to adjusting the profit against inflation to compute the real taxable gains.

Was the tax levied on stock market trades earlier?
Until October 2004, LTCG tax was levied on stock market trades. It was replaced with the Securities transaction tax (STT).  STT is levied at 0.1% of the trade value on all trades made on the stock exchanges.

A study published in 2016 revealed that between 2005-06 and 2011-12, the Centre lost about Rs.3.5 lakh crore by replacing LTCG tax with STT.

The Centre has brought in LTCG tax while retaining STT as well. So, investors will have to pay both the taxes.

Who will be exempt?
When such a tax is introduced, prior investments get some kind of relief. The relief given is called the grandfathering benefit. While reintroducing the LTCG tax, the government has exempted all gains made prior to January 31, 2018. In other words, all the gains made before January 31, 2018 would be grandfathered.

How will the grandfathering benefit work?
Let us consider an example. Suppose a person bought shares in May 2017 at Rs.1000. The value of these shares was Rs.1500 on January 31, 2018. Now, if the person sells the shares at Rs.1800 in June 2018, then his taxable gains would be Rs. 300. (Rs. 1800- Rs. 1500). The gain of Rs. 500 (Rs. 1500- Rs. 1000) will not be taxed.

Will all investors be subject to LTCG tax?
LTCG tax is applicable to all investors who trade on stock exchanges. Only foreign portfolio investors (FPIs), who invest in India from places such as Mauritius and Singapore, are not subject to LTCG tax. This exemption is due to double taxation avoidance treaties. Consequently, foreign investors prefer to invest from Mauritius or Singapore route.

However, Centre is reworking on all such double tax avoidance agreements (DTAA). This benefit would be available only till the time the changes are made into treaty.

How did the stock markets react to the introduction of the tax?

The benchmark equity indices — Sensex and Nifty — lost significant number of points. The introduction of LTCG tax will increase the cost of stocks trading.

(Adapted from PIB)

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